Business Combinations, Joint Venture, Definite-Lived Intangible Assets, Net and Goodwill

Business Combination

Fiscal Year 2015

During the year ended December 31, 2015, VMware completed two business combinations, which were not material to VMware's consolidated financial statements, either individually or in the aggregate. On October 15, 2015, VMware acquired all of the outstanding shares of Boxer, Inc. (“Boxer”) to enhance the enterprise mobile management and security solutions. On February 2, 2015, VMware acquired all of the outstanding shares of Immidio B.V. (“Immidio”) to expand VMware’s workspace environment management solutions within the End-User Computing product group. The aggregate purchase price for these two acquisitions was $39 million of cash, net of liabilities assumed. The preliminary purchase price primarily included approximately $13 million of identifiable intangible assets and approximately $29 million of goodwill that is expected to be non-deductible for tax purposes.

Fiscal Year 2014

Acquisition of AirWatch LLC

On February 24, 2014, VMware acquired for cash all of the outstanding membership units of A.W.S. Holding, LLC (“AirWatch Holding”), the sole member and equity holder of AirWatch LLC (“AirWatch”). AirWatch is a leader in enterprise mobile management and security solutions. VMware acquired AirWatch to expand VMware’s solutions within the enterprise mobile management and security space. The total purchase price of $1,128 million included cash of $1,104 million and the fair value of assumed unvested equity attributed to pre-combination services totaling $24 million.

Merger consideration totaling $300 million, including $75 million that was held in escrow, is payable to certain employees of AirWatch subject to specified future employment conditions and is being recognized as expense over the requisite service period on a straight-line basis. Compensation expense of $145 million and $141 million was recognized during the years ended December 31, 2015 and 2014, respectively.

VMware assumed all of AirWatch’s unvested stock options and restricted stock outstanding at the completion of the acquisition with an estimated fair value of $134 million. Of the total fair value, $24 million was allocated to the purchase price and $110 million was allocated to future services and will be expensed over the remaining requisite service periods on a straight-line basis. The estimated fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model. Pursuant to the purchase agreement, AirWatch’s outstanding stock awards were converted into shares of VMware’s common stock at the conversion ratio of 0.4. The assumed unvested options converted into 1.4 million stock options to purchase VMware Class A common stock. The assumed unvested restricted stock converted into an immaterial number of shares of restricted VMware Class A common stock.

The following table summarizes the allocation of the consideration to the fair value of the assets acquired and liabilities assumed (table in millions):



Cash	$	36
Other current assets	61
Intangible assets	250
Goodwill	868
Other acquired assets	30
Total assets acquired	1,245
Unearned revenues	(45		)
Other assumed liabilities	(72		)
Total liabilities assumed	(117		)
Fair value of assets acquired and liabilities assumed	$	1,128

The excess of the purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Management believes that the goodwill represents the synergies expected from combining the technologies of VMware with those of AirWatch. The estimated fair value assigned to the tangible assets, identifiable intangible assets, and assumed liabilities were based on management’s estimates and assumptions.

The majority of goodwill and identifiable intangible assets is deductible for U.S. income tax purposes.

The following table summarizes the components of the identifiable intangible assets acquired and their estimated useful lives by VMware in conjunction with the acquisitions of AirWatch (amounts in table in millions):



	Useful Lives (in years)	Weighted-Average Useful Lives (in years)	Fair Value Amount
Purchased technology	2 – 6	5.9	$	118
Customer relationships and customer lists	2 – 8	7.9	78
Trademarks and tradenames	8	8	40
Other	2 – 8	3.2	14
Total identifiable intangible assets			$	250

The following pro forma financial information summarizes the combined net income for VMware and AirWatch, which was significant for purposes of the unaudited pro forma financial information disclosure, as though the companies were combined at the beginning of the Company’s fiscal year 2013. The amount of revenue from AirWatch was not considered material, and as such, has not been separately presented in the unaudited pro forma financial information disclosure below.

Supplemental information on an unaudited pro forma basis as if AirWatch had been acquired on January 1, 2013 is presented as follows (table in millions):



	For the Year Ended December 31,
	For the Year Ended December 31,
	2014		2013
Pro forma adjusted net income	$	849	$	781

Pro forma adjustments primarily include compensation expense for certain key employees subject to specified future employment conditions, intangible amortization, stock-based compensation and related tax effects.

Other 2014 Business Combinations

During the year ended December 31, 2014, VMware completed three business combinations in addition to AirWatch, which were not material to VMware’s consolidated financial statements, either individually or in the aggregate. On August 20, 2014, VMware acquired CloudVolumes, Inc. (“CloudVolumes”), a provider of real-time application delivery technology that enables enterprises to deliver native applications to virtualized environments on-demand. Additionally, in the fourth quarter of 2014, VMware completed two other immaterial business combinations. The aggregate purchase price for these three acquisitions was $91 million, net of cash acquired. The purchase price primarily included $19 million of identifiable intangible assets and approximately $73 million of goodwill. Of the goodwill acquired, $23 million is deductible for income tax purposes.

Fiscal Year 2013

During the year ended December 31, 2013, VMware completed two business combinations. On October 10, 2013, VMware acquired Desktone, Inc. (“Desktone”), a provider of desktop-as-a-service for delivering Windows desktops and applications as a cloud service. On February 15, 2013, VMware acquired Virsto Software (“Virsto”), a provider of software that optimizes storage performance and utilization in virtual environments.

The aggregate consideration for these two acquisitions was $289 million, net of cash acquired. The following table summarizes the allocation of the consideration to the fair value of the assets acquired and net liabilities assumed (table in millions):



Intangible assets	$	62
Goodwill	233
Deferred tax assets, net	4
Total assets acquired	299
Other assumed liabilities, net of other acquired assets	(10		)
Total net liabilities assumed	(10		)
Fair value of assets acquired and net liabilities assumed	$	289

The excess of the consideration for Desktone and Virsto over the fair values assigned to the assets acquired and liabilities assumed represents the goodwill resulting from the acquisitions. Management believes that the goodwill represents the synergies expected from combining the technologies of VMware with those of Desktone and Virsto, including complementary products that will enhance the Company’s overall product portfolio. No goodwill was deductible for tax purposes.

The following table summarizes the fair value of the intangible assets acquired by VMware in conjunction with the acquisitions of Desktone and Virsto (amounts in table in millions):



	Weighted-Average Useful Lives (in years)	Fair Value Amount
Purchased technology	6	$	49
Vendor contracts	8	3
In-process research and development (“IPR&D”)		10
Total intangible assets, net, excluding goodwill		$	62

As of December 31, 2013, $9 million of the $10 million in IPR&D shown in the table above was completed and transferred to purchased technology with a weighted-average life of 5 years. The remaining IPR&D was completed and transferred to purchased technology during the year ended December 31, 2014.

The results of operations of Desktone and Virsto described above have been included in VMware’s consolidated financial statements from their respective date of purchase. Pro forma results of operations have not been presented as the results of the acquired businesses were not material to VMware’s consolidated results of operations in the year ended December 31, 2013.

Joint Venture

During the year ended December 31, 2014, VMware established a joint venture intended to expand VMware vCloud Air services (formerly vCloud Hybrid Service) in Japan. At December 31, 2015, VMware had a controlling interest in the joint venture and approximately 51% of the ownership. Accordingly, VMware consolidated the financial results of the joint venture. The share of the earnings in the joint venture attributable to the non-controlling interests was not material during the years ended December 31, 2015 and 2014.

Definite-Lived Intangible Assets, Net

The following table summarizes the changes in the carrying amount of definite-lived intangible assets for the years ended December 31, 2015 and 2014 (table in millions):



	December 31,
	2015			2014
Balance, beginning of the year	$	748		$	607
Additions to intangible assets related to business combinations	13			278
Amortization Expense	(145		)	(141		)
Other adjustments	—			4
Balance, end of the year	$	616		$	748

As of December 31, 2015 and 2014, definite-lived intangible assets consisted of the following (amounts in tables in millions):



	December 31, 2015
	Weighted-Average Useful Lives (in years)	Gross Carrying Amount		Accumulated Amortization			Net Book Value
Purchased technology	6.6	$	648	$	(298	)	$	350
Leasehold interest	34.9	149		(20		)	129
Customer relationships and customer lists	8.4	148		(62		)	86
Trademarks and tradenames	8.6	61		(16		)	45
Other	2.9	20		(14		)	6
Total definite-lived intangible assets		$	1,026	$	(410	)	$	616



	December 31, 2014
	Weighted-Average Useful Lives (in years)	Gross Carrying Amount		Accumulated Amortization			Net Book Value
Purchased technology	6.5	$	699	$	(252	)	$	447
Leasehold interest	34.9	149		(15		)	134
Customer relationships and customer lists	8.2	157		(53		)	104
Trademarks and tradenames	8.6	61		(9		)	52
Other	2.7	18		(7		)	11
Total definite-lived intangible assets		$	1,084	$	(336	)	$	748

During the years ended December 31, 2015, 2014 and 2013, amortization expense was $145 million, $141 million, and $107 million, respectively.

Based on intangible assets recorded as of December 31, 2015 and assuming no subsequent additions or impairment of underlying assets, the remaining estimated annual amortization expense is expected to be as follows (table in millions):



2016	$	129
2017	122
2018	109
2019	88
2020	38
Thereafter	130
Total	$	616

Goodwill

The following table summarizes the changes in the carrying amount of goodwill during the years ended December 31, 2015 and 2014 (table in millions):



	December 31,
	2015		2014
Balance, beginning of the year	$	3,964	$	3,027
Increase in goodwill related to business combinations	29		941
Deferred tax adjustments to purchase price allocations on acquisitions	—		(4		)
Balance, end of the year	$	3,993	$	3,964